CYPRUS: Fiscal Council worried over government spending trends

29 December, 2018

Cyprus Fiscal Council is uneasy over the government conceding to various groups, from lateral pay hikes across the public sector to consider the inclusion of borrowers who are paying off their loans to the ESTIA scheme aimed at mortgage defaulters.

Designed as an independent institution to evaluate and validate the government’s macroeconomic predictions and budget, the council is concerned that, while these concessions alone are not enough to derail the government’s fiscal policy, they are however building up a trend which may pose a threat, said the council’s president Demetris Georgiades in an interview with the Financial Mirror.

Georgiades referred to the risks still facing Cyprus’ economy and measures needed to be taken.

The Fiscal Council was created in 2014 as a result of discussions in the European Union following the euro crisis that began in 2007.

During that period changes were made in the banking system and new fiscal regulations were adopted at the European Union level.

Among the directives issued by the EU was the creation of independent fiscal institutions which are to monitor the government’s fiscal policies and evaluate its macroeconomic predictions.

“Our role is more to exert political cost to the government in order to keep in line with its fiscal policy. The government will have to justify why it does not wish to follow the advice of the Fiscal Council,” said Georgiades.

The Council does have the authority to say no, however, the final say belongs to the Finance Minister.

What it can do if the government derails from its fiscal program, is to suggest the activation of the automatic correction mechanism.

“This is essentially a European mechanism...it foresees that measures should be taken in case your deficit; your debt is out of control. These measures are pre-decided by the government but are evaluated by the council and the European Union.

First, the EU will issue warnings, then it will start cutting funds, followed by financial sanctions. This is what is happening with Italy which has to send its budget to the EU for approval,” said the council head.

He said that in reality countries not complying will be forced out by the markets. “Italy may find itself left out if Italy insists on its current path”.

Governments of member states are obliged to submit medium-term fiscal plans to the EU for three years. The discussion revolve around how binding these plans are and what role will the fiscal councils have.

The EU is now talking about the creation of a European Fiscal council.

“Budgets and fiscal policies are things that have to do with political decisions of democratically elected governments”.

Georgiades said the councils do not have the authority to dictate to the governments where to spend what, they can, however, issue warnings if they find that the way funds are used endanger the economy in the future, such as what is happening with education in Cyprus.

He said the council has intervened on the matter as it finds that compared to funds going into the education system, the results are appalling.

Challenges

Georgiades said that the biggest challenge is that “fiscal mistakes are made in periods of growth”.

“We need to find ways to make the most of the good periods. However, convincing policymakers is not always an easy task”.

He said that Cyprus’ debt is close to 100% of GDP, while households and businesses are amongst the most indebted in the world.

“There is also the danger of a trade war, regional challenges, the issue with Italy. If there is a shock in the EU, the euro will come under pressure with markets becoming more conservative.”

Cyprus, just like the rest of the EU has a serious problem with NPLs.

“Things are looking up for Cyprus, as despite having a bigger NPL problem than the rest of the EU, we were able to achieve primary surpluses and reduce unemployment. However, now that we appear to be coming out of the woods, we have started handing out concessions.”

According to Georgiades, these concessions may not be destructive on their own, but they seem to be building a trend.

“The threat lies in that you are creating a precedent of a moral hazard. If you give to a group a raise which is not rationalyou will push other social groups to come out with their own demands.”

“Like in the case of the reduction of the consumption tax on fuel. This reduction did not have a rational base, it was not done for example with the aim to help out a certain sector, e.g. the agricultural sector, with a temporary measure. Instead, it had a lateral application, there will be groups of people who do not have cars who will also demand their share of benefits”.

He said now is not the time to be reducing consumption taxes.

“In good times we should be saving as a state and encouraging people to save up. We have a growth rate of almost 4% and unemployment has dropped under 8% and declining. There is no need to push more money into consumption. This is what we’re doing… we are telling people to spend more.”

“We are not against pay raises. What we believe is that these surpluses should be used in a rational manner. They should be saved for when people and the economy will really need them, while measures should be targeted”.

He said that a good example of non-targeted measures is the ESTIA scheme designed to help borrowers defaulting on their mortgages.

“The fact that criteria are not as strict as they should have been, has caused a moral hazard. Groups who feel they have been wronged, in this case, people who were paying their loans, despite being in grave financial difficulties, are paying their loans while other people were strategically defaulting.”

Politicians are now talking about, ESTIA II which is to cover borrowers who have been paying off their loans.

“What politicians should have done was to regulate the ESTIA with tighter criteria, targeting the truly vulnerable layers of society, leaving no space for moral hazard”.

Georgiades stressed that now is the time to continue with corrective measures. Good periods are the best time to perform corrective measures.

“If you are to give out raises you should be taking into to consideration the needs of the economy. What is happening now is that the government is handing out lateral raises, without taking into consideration the payroll in the private sector, what is paid out for the same services in the rest of the EU”.

Reforming the justice system

The state needs to proceed with adopting measures that will reform the justice system in Cyprus, making it more credible to outsiders.

“We are talking about reducing the Banks’ NPE. Efforts to sell off NPLs are hindered by the fact that we do not have a clear justice system regarding repossessions, with laws that keep changing, and some repossession cases could be in the courts for the next 10 years”.

A result of the unclear regulatory system regarding almost all aspects of the society, but especially the banking system, saw big banking institutions like HSBC leave the island.

“Whatever people may say about this particular institution, it was still a sizeable bank which left because of holes in the legal system. And who did we replace it with? With people and institutions who knew how to manipulate such systems and eventually led to the downfall of our banking system,” said Georgiades.